Results of Operations, Financial Position and Net Assets

The Volkswagen Group’s segment reporting comprises the four reportable segments Passenger Cars, Commercial Vehicles, Power Engineering and Financial Services, in compliance with IFRS 8 and in line with the Group’s internal management and reporting.

At Volkswagen, segment result is measured on the basis of the operating result.

The reconciliation column contains activities and other operations that do not by definition constitute segments. These include the unallocated Group financing activities. The reconciliation also contains consolidation adjustments between the segments (including the holding company functions). Purchase price allocation for Porsche Holding Salzburg and Porsche, Scania and MAN reflects their accounting treatment in the segments.

The Automotive Division comprises the passenger cars, commercial vehicles and power engineering segments, as well as the figures from the reconciliation. The passenger cars segment and the reconciliation are combined to form the Passenger Cars Business Area; for commercial vehicles and power engineering, the segment is the same as the business area. The Financial Services Division corresponds to the financial services segment.

SALE OF THIRD-PARTY-BRAND DEALERSHIPS OF PORSCHE HOLDING SALZBURG

The sale of part of the PGA Group SAS to the Emil Frey Group was executed on June 1, 2017. The sale was made in connection with the strategic development of Porsche Holding Salzburg’s dealer network and the corresponding focus on dealerships exclusively selling Volkswagen Group brand vehicles. This had a positive effect of €0.8 billion on the Group’s net liquidity and, taking into account the disposal of the assets and liabilities, resulted in immaterial income for the Group, which was reported in other operating income.

SPECIAL ITEMS

Special items consist of certain items in the financial statements whose separate disclosure the Board of Management believes can enable a better assessment of our economic performance.

In fiscal year 2017, negative special items recognized in the operating profit amounted to €−3.2 (−7.5) billion. In the reporting period, these related exclusively to charges in the Passenger Cars Business Area in connection with the diesel issue, primarily due to higher expenses attributable to the buyback/retrofit programs for 2.0 l and 3.0 l TDI vehicles in North America and to higher legal risks. In fiscal year 2016, these items amounted to €−6.4 billion.

The prior-year period also contained additional special items in the Passenger Cars Business Area for potentially faulty airbags manufactured and supplied by Takata (€−0.3 billion), as well as for restructuring measures in the Passenger Cars (€−0.2 billion), Commercial Vehicles (€−0.1 billion) and Power Engineering (€−0.2 billion) business areas. In 2016, provisions recognized in connection with the commercial vehicles antitrust proceedings launched by the European Commission also led to special items (€−0.4 billion) in the Commercial Vehicles Business Area.

RESULTS OF OPERATIONS

Results of operations of the Group

In 2017, the Volkswagen Group’s sales revenue increased by 6.2% year-on-year to €230.7 billion. In particular, higher volumes and the healthy business performance in the Financial Services Division had a positive effect, while exchange rates had a negative impact. At 80.8 (79.9)% the major share of sales revenue was recorded outside Germany.

Gross profit improved by €1.5 billion to €42.5 billion. Adjusted for special items recorded under this item in both periods, gross profit increased to €44.8 (42.5) billion. The gross margin amounted to 18.4 (18.9)%; excluding special items it was 19.4 (19.6)%.

In the reporting period, the Volkswagen Group generated an operating profit before special items of €17.0 (14.6) billion; the operating return on sales before special items rose to 7.4 (6.7)%. The increase was mainly the result of positive volume-, mix- and margin-related factors, as well as improvements in product costs, while higher fixed costs as a result of expansion and higher depreciation and amortization charges due to the large volume of capital expenditure had an offsetting effect. Negative special items weighed on operating profit, reducing this item by a total of €−3.2 (−7.5) billion. At €13.8 billion, the Volkswagen Group’s operating profit was up €6.7 billion on the previous year. The operating return on sales rose to 6.0 (3.3)%.

SHARE OF SALES REVENUE BY MARKET 2017
in percent

SHARE OF SALES REVENUE BY DIVISION/BUSINESS AREA 2017
in percent

The financial result declined to €0.1 (0.2) billion. Lower interest expenses and lower expenses from the measurement of derivative financial instruments at the reporting date had a positive effect, while foreign currency measurement had a negative impact. The share of the result of equity-accounted investments was at the prior-year level. This includes the gain on the remeasurement of the investment in HERE following the acquisition of shares by additional investors. In the prior-year period, the income from the sale of the LeasePlan shares had a positive effect.

The Volkswagen Group’s profit before tax rose to €13.9 billion in the reporting period, up €6.6 billion on the prior-year figure. The return on sales before tax improved from 3.4% to 6.0%. Profit after tax amounted to €11.6 (5.4) billion. Although income taxes increased, the tax rate of 16.3 (26.2)% was considerably lower in the reporting period. This decline was due to the tax reform in the USA passed at the end of the year, which led to a non-recurring positive non-cash measurement effect on deferred taxes of €1.0 billion.

Results of operations in the Automotive Division

The Automotive Division’s sales revenue amounted to €196.9 billion in fiscal year 2017, thus exceeding the prior-year figure by €10.9 billion. The improvement resulted primarily from higher vehicles sales, which were offset by negative exchange rate effects. As our Chinese joint ventures are accounted for using the equity method, the Group’s business performance in the Chinese passenger car market is reflected in consolidated sales revenue primarily by deliveries of vehicles and vehicle parts.

Cost of sales increased due to larger volumes; in addition, a rise in special items and higher depreciation and amortization charges had a negative impact, while improvements in product costs had a positive effect. Total research and development costs as a percentage of the Automotive Division’s sales revenue (research and development ratio or R&D ratio) declined to 6.7 (7.3)% in the reporting period as a result of higher sales revenues and lower expenses. In addition to new models, our activities focused above all on the electrification of our vehicle portfolio, a more efficient range of engines, and digitalization. Expressed as a percentage of sales revenue, cost of sales rose slightly year-on-year.

The gross profit of the Automotive Division improved to €36.3 (35.2) billion.

Distribution expenses were on a level with the previous year, which had been impacted by negative special items. Exchange rate effects weighed on the 2017 figure. The ratio of distribution expenses to sales revenue declined. Administrative expenses as well as their ratio to sales revenue increased compared with the previous year. At €2.7 billion in fiscal year 2017, the net other operating result exceeded the prior year by €6.0 billion, driven in particular by much lower negative special items in connection with the diesel issue and by exchange rate effects.

The operating profit of the Automotive Division improved by €6.5 billion to €11.1 billion. The operating return on sales stood at 5.7 (2.5)%. Negative special items contained in operating profit totaled €−3.2 (−7.5) billion. These items were exclusively attributable to the Passenger Cars Business Area in the reporting period, reflecting charges in connection with the diesel issue. Excluding the special items, the Automotive

Division’s operating profit rose to €14.4 (12.2) billion. The operating return on sales before special items increased to 7.3 (6.6)%. The main contributors were improvements in volumes, the mix and margins, as well as product cost optimization; these factors were offset by higher fixed costs as a result of expansion and higher depreciation and amortization charges. Operating profit benefited from the business performance of our Chinese joint ventures primarily in the form of deliveries of vehicles and vehicle parts and of license income, as the joint ventures are accounted for using the equity method and therefore included in the financial result.

The Passenger Cars Business Area generated sales revenue of €158.5 billion in fiscal year 2017, thus exceeding the prior-year figure by 5.4%, mainly because of volume-related factors. Exchange rates had a negative effect. The operating profit of €9.3 billion generated in the Passenger Cars Business Area was up €5.1 billion on the previous year. Special items included in this item decreased significantly year-on-year to €−3.2 (−6.9) billion. Improvements in volumes, the mix and margins, and product cost optimization had a positive influence, while a rise in fixed costs and higher depreciation and amortization charges had a negative impact. The operating return on sales rose to 5.9 (2.8)%.

The Commercial Vehicles Business Area recorded sales revenue of €35.2 billion in the reporting period, €3.1 billion more than in the previous year; this increase was driven mainly by larger volumes. The operating profit of the Commercial Vehicles Business Area improved by €1.2 billion to €1.9 billion; the operating return on sales climbed to 5.4 (2.2)%. The increase versus the previous year, which had been negatively impacted by special items, was mainly the result of positiv volume- and margin-related factors and the expansion of the service business.

The Power Engineering Business Area’s sales revenue of €3.3 billion in fiscal year 2017 was 8.6% lower than in the previous year. The operating loss declined by €0.2 billion to €−0.1 billion. Lower volumes were offset by positive mix effects. Special items had a negative impact in the previous year. The operating return on sales improved from −6.0% to −1.7%.

Results of operations in the Financial Services Division

In the Financial Services Division, sales revenue increased by 7.9% year-on-year to €33.7 billion in fiscal year 2017, due mainly to the growth in business volumes.

As a result, gross profit went up by €0.4 billion to €6.2 billion.

Both distribution and administrative expenses increased year-on-year; in addition to higher volumes, the rise in expenses was attributable in particular to digitalization. The ratio of distribution and administrative expenses to sales revenue was unchanged. The net other operating result amounted to €−0.5 (−0.6) billion.

The 9.8% year-on-year increase in operating profit to €2.7 billion reflects the Financial Services Division’s sustained contribution to the Group’s success. The operating return on sales improved to 7.9 (7.8)%. The return on equity before tax was 9.8%, compared with 10.8% in the previous year.

PRINCIPLES AND GOALS OF FINANCIAL MANAGEMENT

Financial management at the Volkswagen Group covers liquidity management, currency, interest rate and commodity risk management, as well as credit and country risk management. It is performed centrally for all Group companies by Group Treasury, based on internal directives and risk parameters. The main areas of the MAN and Porsche Holding Salzburg subgroups are integrated into the financial management of the Group, while Scania is covered to a limited extent. Additionally, these subgroups have their own financial management structures.

The goal of liquidity management is to ensure that the Volkswagen Group remains solvent at all times and at the same time to generate an adequate return from the investment of surplus funds. We use cash pooling to optimize the use of existing liquidity between the significant companies in Europe. To do this, the balances, either positive or negative, accumulating in the cash pooling accounts are swept daily into a target account at Group Treasury and thus pooled. Currency, interest rate and commodity risk management is designed to hedge the prices on which investment, production and sales plans are based using derivative financial instruments. Credit and country risk management aims to limit the Volkswagen Group’s exposure to the risk of loss or default by means of diversification. To achieve this, internal limits are defined on the basis of various credit risks for the volume of business per counterparty when entering into financial transactions. These primarily focus on the capital resources of potential counterparties, as well as the ratings awarded by independent agencies. The relevant risk limits and the authorized financial instruments, hedging methods and hedging horizons are approved by the Group Board of Management Committee for Risk Management, which replaced the Group Board of Management Committee for Liquidity and Foreign Currency in the reporting period.

For additional information on the principles and goals of financial management, please refer to chapter “Financial risks” and to the notes to the 2017 consolidated financial statements.